Are you thinking about starting a business?
(If you are selling for profit and not just a hobby then you need start thinking about forming a business/business entity. See my previous BLOG; Business vs Hobby)
Have you thought about what Business Entity is best for you/your business?
Do you know what a business entity is & why it's important?
A BUSINESS ENTITY is an entity that is formed and administered as per commercial law in order to engage in business activities, charitable work, or other activities allowable. Most often, business entities are formed to sell a product or a service.
The four ways in which a business may be set up are: Sole Proprietorship, Partnership, Corporation, and Limited Liability Company.
Of all the choices you make when starting a business, one of the most important is the type of legal structure you select for your company.
Not only will this decision have an impact on how much you pay in taxes, it will affect the amount of paperwork your business is required to do & the personal liability you face.
Please Note: No legal structure is inherently better than another; which one is right for your business is something that you & or the other business owner(s) will need to decide at the time of starting the business.
In this blog I will give descriptions of entities, but you may want to seek the advice of an attorney & or an accountant to help determine what's best for you/your business.
The simplest legal structure for a business is the sole proprietorship, a business that’s owned by one individual or a married couple.
Most new business with only one owner start out as sole proprietorships. Some never change their statuses, but others grow by adding partners and becoming partnerships. Some add lots of staff and want to protect themselves from lawsuits, so they become Limited Liability Companies (LLCs). Those seeking the greatest protection from individual lawsuits, whether they have employees or are simply single-owner companies without employees, become corporations.
SOLE PROPRIETOR TAX FILING;
As a sole proprietor you must report all business income or losses on your personal income tax return; the business itself is not taxed separately. (The IRS calls this "pass-through" taxation, because business profits pass through the business to be taxed on your personal tax return.)
The partnership is the most flexible type of business structure involving more than one owner. Each partner in the business is equally liable for the activities of the business. This structure is slightly more complicated than a sole proprietorship and partners should work out certain key issues before the business opens its doors. These issues include;
How the partners will divide the profits
How each partner can sell his or her share of the business, if he or she so chooses
What will happen to each partner’s share if a partner becomes sick or dies
How the partnership will be dissolved if one of the partners wants out
Partners in a partnership don’t always have to share equal risks. A partnership may have two different types of partners: general and limited. The general partner runs the day-to-day business and is held personally responsible for all activities of the business, no matter how much he or she has personally invested in the business. Limited partners, on the other hand, are passive owners of the business and not involved in its day-to-day operations. If a claim is filed against the business, the limited partners can only be held personally liable for the amount of money that matches how much they individually invested in the business.
PARTNERSHIP TAX FILING;
Partnerships file an information return to report their income, gains, losses, deductions, credits, etc. A partnership does not pay tax on its income but “passes through” any profits or losses to its partners. (Therefore if you or your partner(s) keep $ of profits from the partnership that $ will be taxed as personal income to whomever keeps it.)
LIMITED LIABILITY COMPANIES (LLCs)
The Limited Liability Company, or LLC, is a structure that provides partnerships and sole proprietorships with some protection from being held personally liable for their businesses’ activities. This business structure is somewhere between a sole proprietorship or partnership and a corporation: The business ownership and IRS tax rules are similar to those of a sole proprietorship or partnership, but like a corporation, if the business is sued, the owners aren’t held personally liable.
LLCs are state entities, so the level of legal protection given to a company’s owners depends upon the rules of the state in which the LLC was formed.
LLC TAX FILING;
A disregarded entity is treated the same as a sole proprietor, so your LLC's income will be treated like personal income. If you choose corporate taxation, your business will be taxed at a lower corporate rate for the first $75,000 of income. Any LLC can choose this tax treatment by filing IRS form 8832.
If your business faces a great risk of being sued, the safest business structure for you is the corporation. Courts in the United States have clearly determined that a corporation is a separate legal entity and that its owners’ personal assets are protected from claims against the corporation. Essentially, an owner or shareholder in a corporation can’t be sued or face collections because of actions taken by the corporation. This veil of protection is the reason many small business owners choose to incorporate even though it involves a lot of expense (both for lawyers and accountants) and government paperwork.
CORP TAX FILING;
Pass-through taxation. An S corporation does not pay federal taxes at the corporate level. ... Any business income or loss is "passed through" to shareholders who report it on their personal income tax returns. This means that business losses can offset other income on the shareholders' tax returns.
C Corps Pay Their Own Taxes. A regular corporation (also known as a C corporation) is taxed as a separate entity. The corporation must file a Form 1120 each year to report its income and to claim its deductions and credits.
Hopefully now you have some indication of what direction would be best for you/your business. If not, you'll at least be able to have a more educated conversation with your accountant & or attorney!